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“Hoovervilles” were shantytowns that had sprung up all across Americaas a result of The Great Depression.

The shantytowns got their derisive name from Herbert Hoover, who hadbeen elected president in 1928.

Hoover lost his bid for reelection because many Americans blamedhim for the Depression.

Macroeconomics came into its own as a branch of economics during theGreat Depression. Economists realized that they needed to understandthe nature of the catastrophe that had overtaken the United States.

To this day, the effort to understand economic slumps and find ways toprevent them is at the core of macroeconomics.

Over time, however, macroeconomics has broadened its reach toencompass a number of other subjects, such aslong-run economicgrowth,inflation, andopen-economy

macroeconomics.

This chapter offers an overview of macroeconomics.

1.Macro vs. Microeconomics

2.The importance of thebusiness cycle

and whypolicy-makers seek to diminish the severity ofbusiness cycles

3.Whatlong-run growthis and how it determines acountry’s standard of living

4.The meaning ofinflationanddeflation

and whyprice stabilityis preferred

5.What is special about the macroeconomics of anopen economy, an economy that trades goods,services, and assets with other countries

Chapter Objectives

Macroeconomics vs. Microeconomics

Let’s begin by looking more carefully at the differencebetween microeconomic and macroeconomic questions.

MICROECONOMICQUESTIONS

MACROECONOMICQUESTIONS

Go to business school or takea job?

How many people areemployed in the economy asa whole?

What determines the salaryoffered by Citibank to CherieCamajo, a new ColumbiaMBA?

What determines the overallsalary levels paid to workersin a given year?

MICROECONOMICQUESTIONS

MACROECONOMICQUESTIONS

What determines the cost to auniversity or college of offeringa new course?

What determines the overalllevel of prices in the economyas a whole?

What government policiesshould be adopted to make iteasier for low-income studentsto attend college?

What government policiesshould be adopted to promotefull employment and growth inthe economy as a whole?

What determines whetherCitibank opens a new office inShanghai?

What determines the overalltrade in goods, services andfinancial assets between theU.S. and the rest of the world?

Macroeconomics vs. Microeconomics

Microeconomics

focuses on how decisions aremade by individuals and firms and theconsequences of those decisions.

Example:

How much it would cost for auniversity or college to offer a new course─

the cost of the instructor’s salary, theclassroom facilities, the class materials, andso on. Once cost is calculated, the schoolcan then decide whether or not to offer thecourse by weighing the costs and benefits.

Macroeconomics vs. Microeconomics

Macroeconomicsexamines theaggregatebehavior of the economy (i.e.how the actions of all the individuals andfirms in the economy interact to producea particular economic-wide level ofeconomic performance).

Example:

Overall level of prices in the economy(how high or how low they are relative to prices lastyear) rather than the price of a particular good orservice.

Macroeconomics vs. Microeconomics

In macroeconomics, the behavior of the wholeis,greater than the sum

of individual actionsand market outcomes.

Example:

Paradox of thrift:when families andbusinesses are worried about the possibility ofeconomic hard times, they prepare by cutting theirspending.

This reduction in spending depresses the economyas consumers spend less and businesses react bylaying off workers.

As a result, families and businesses may end upworse off than if they hadn’t tried to act responsiblyby cutting their spending.

Macroeconomics vs. Microeconomics

Macroeconomics: Theory and Policy

In aself-regulating economy,problems likeunemployment are resolved without governmentintervention, through the invisible hand.

According toKeynesian economics,economicslumps are caused by inadequate spending and theycan be mitigated by government intervention.

Herbert Hoover didn’t do much to fight the Great Depression. Atthe time, conventional wisdom dictated that the government take ahands-off approach to the economy.

Leading economists, including Joseph Schumpeter, offered similaradvice. “Remedial measures which work through money and credit.Policies of this class are particularly apt to produce additionaltrouble for the future.”

Under President George W. Bush: The 2004Economic Report ofthe Presidentstated “Strong fiscal policy actions by thisAdministration and the Congress, together with the FederalReserve’s stimulative monetary policy,” the report declared, “havesoftened the impact of the recession and have also put theeconomy on an upward trajectory.”

Why George W. Bush Wasn’t HerbertHoover

The boost to the economy given by fiscal policy and theFederal Reserve’s interest rate cuts reduced the severityand duration of the 2001 recession.

Why George W. Bush Wasn’t HerbertHoover

1.microeconomics

2.macroeconomics

1a) Why did consumers switch to smaller cars in 2008?

Which of the following questions involve microeconomics

and which involve macroeconomics?

1b) Why did overall consumer spending slow down in 2008?

1.microeconomics

2.macroeconomics

1.microeconomics

2.macroeconomics

1c) Why did the standard of living rise more rapidly in thefirst generation after World War II than in the second?

1d) Why have starting salaries for students with geologydegrees risen sharply of late?

1.microeconomics

2.macroeconomics

Which of the following questions involve microeconomics

and which involve macroeconomics?

1.microeconomics

2.macroeconomics

1e) What determines the choice between rail and roadtransportation?

1f) Why has salmon gotten cheaper over the past 20years?

1.microeconomics

2.macroeconomics

Which of the following questions involve microeconomics

and which involve macroeconomics?

1.microeconomics

2.macroeconomics

1g) Why did inflation fall in the 1990s?

Which of the following questions involve microeconomics

and which involve macroeconomics?

1.True

2.False

1) True or False? Drying up of credit usually has littleimpact on the economy beyond the financial sector.

In 2008 problems in the financial sector led to a drying up of creditaround the country: homebuyers were unable to get mortgages,students were unable to get loans, car buyers were unable to get carloans, etc.

1.True

2.False

2) True or False? If you believed the economy was self-regulating, then you would advocate decreasing taxes inresponse to the slump.

3) True or False? If you believed in Keynesian economics,you would advocate monetary and/or fiscal policy inresponse to the slump.

1.True

2.False

In 2008 problems in the financial sector led to a drying up of creditaround the country: homebuyers were unable to get mortgages,students were unable to get loans, car buyers were unable to get carloans, etc.

The Business Cycle

Thebusiness cycle

is the short-run alternationbetween economic downturns and economicupturns.

Adepression

is a very deep and prolongeddownturn.

Growth, Interrupted, 1988-2009

The Business Cycle

Recessions

are periods of economic downturnswhen output and employment are falling.

The point at which the economy turns fromexpansion to recession is abusiness-cyclepeak.

The point at which the economy turns fromrecession to expansion is abusiness-cycletrough.

Charting theBusiness Cycle

Table 10-2 shows the official listof business-cycle peaks and

troughs, as declared by theNational Bureau of Economic

Research.

Whenever there is a prolongedexpansion books and articlescome out proclaiming the

end of the business cycle.

Such proclamations have always

proved wrong: The cycle alwayscomes back.

Charting the Business Cycle

In many countries, economists adopt the rule that arecession is a period of at least 6 months, or twoquarters, during which aggregate output falls.



sometimes too strict

In the U.S., the task of determining when a recessionbegins and ends is assigned to an independent panel ofexperts at the National Bureau of Economic Research(NBER). They look at a number of economic indicators,with the main focus on employment and production,but ultimately the panel makes a judgment call.

In 1905, we find that life for manyAmericans was startlingly primitive bytoday’s standards.

Americans have become able to affordmany more material goods over timethanks to long-run economic growth.

Long-run growth is a relatively modern phenomenon.

From 1000 to 1800, real aggregate output around the worldgrew less than 0.2% per year, with population rising atabout the same rate.

Economic stagnation meant unchanging living standards. Forexample, information on prices and wages from such sourcesas monastery records shows that workers in England weren’tsignificantly better off in the early eighteenth century thanthey had been five centuries earlier.

In the last 50 years or so, real GDP per capita has grownabout 3.5% per year.

When Did Long-Run Growth Start?

The Fruits of Long-Run Growth in America

Growth, the Long View

One of the most informative contrasts in long-run growth isbetween Canada and Argentina.

Economic historians believe that the average level of percapita income was about the same in the two countries aslate as the 1930s.

After World War II, however, Argentina’s economyperformed poorly, largely due to political instability and badmacroeconomic policies.

Meanwhile, Canada made steady progress. Thanks to thefact that Canada has achieved sustained long-run growthsince 1930, but Argentina has not, Canada today has almostas high a standard of living as the United States—and isabout three times as rich as Argentina.

A Tale of Two Colonies

Countries with a high population growth rate:

1.typically have low unemploymentrates.

2.benefit from an increase in the workforce.

3.must experience above averageoutput growth in order to increase thestandard of living.

4.experience unprecedented rises inliving standards.

True or False? Argentina used to be as rich as Canada.Because Argentina is poorer than Canada now, Argentina ispoorer now than it was in the past.

1.True

2.False

Inflation and Deflation

A rising aggregate price level isinflation.

A falling aggregate price level isdeflation.

Theinflation rate

is the annual percentchange in the aggregate price level.

The economy hasprice stability

whenthe aggregate price level is changing onlyslowly.

Causes of Inflation and Deflation

Supply and Demand can only explain why a goodbecame more expensive relative to other goods

It cannot explain why the price of chicken has risenover time in spite of the fact that chickenproduction has become more efficient and cheaper.

Overall level of prices is mainly determined by themoney supply.

Price stability is when the overall level of priceschanges slowly or not at all.

Inflation and Deflation

McDonald’s opened in 1954: Hamburgers cost only 15cents─25 cents with fries.

Today a hamburger at a typical McDonald’s costs five timesas much─between $0.70 and $0.80.

Is this too expensive?

No. In fact, a burger is, compared with other consumergoods, a better bargain than it was in 1954.

Burger prices have risen about 400%, from $0.15 to about$0.75, over the last half century. But the overall consumerprice index has increased more than 600%.

If McDonald’s had matched the overall price level increase, ahamburger would now cost between 90 cents and $1.00.

A Fast (Food) Measure of Inflation

Gasoline prices are up 10%, food prices are down 20%,and the prices of most services are up 1-2%.

1.inflation

2.deflation

3.ambiguous

Which of these sound like inflation, which sound like deflation,

and which are ambiguous?

Gas prices have doubled, food prices are up 50%, andmost services seem to be up 5 or 10%.

No, Estonia runs trade deficits that are small in dollar terms butlarge compared with the size of the economy. Relative to the size ofits economy, Estonia's trade deficit in 2007 was almost three timesthat of the United States.

Why does Estonia run such large trade deficits? Because it’s sosuccessful!

The success of the economy has led to high rates of investment,much of it by companies based in other European countries. Aswe’ve just suggested, trade deficits are high when investmentspending is high compared with savings.

Estonia’s Miraculous Trade Deficit

Thanks to the discovery of huge oil sands in Alberta,Canada, it has become an exporter of oil and an importerof manufactured goods.

1.comparative advantage

2.macroeconomic forces

Which of the following reflect comparative advantage,and which reflect macroeconomic forces?

Like many consumer goods, the Apple iPod is assembled inChina, although many of the components are made inother countries.

1.comparative advantage

2.macroeconomic forces

Which of the following reflect comparative advantage,and which reflect macroeconomic forces?

Since 2002, China has been running huge trade surpluses,exporting much more than it imports.

1.comparative advantage

2.macroeconomic forces

Which of the following reflect comparative advantage,and which reflect macroeconomic forces?

The United States, which had roughly balanced trade in theearly 1990s, began running large trade deficits later in thedecade, as the technology boom took off.

1.comparative advantage

2.macroeconomic forces

Which of the following reflect comparative advantage,and which reflect macroeconomic forces?

1.Macroeconomics is the study of the behavior of the economyas a whole. Macroeconomics differs from microeconomics inthe type of questions it tries to answer and in its strong policyfocus.Keynesian economics,which emerged during theGreat Depression, advocates the use ofmonetary policyandfiscal policyto fight economic slumps. Prior to the GreatDepression, the economy was thought to beself-regulating.

2.One key concern of macroeconomics is thebusiness cycle,the short-run alternation betweenrecessions,periods offalling employment and output, andexpansions,periods ofrising employment and output. The point at which expansionturns to recession is abusiness-cycle peak.The point atwhich recession turns to expansion is abusiness-cycletrough.

4.When the prices of most goods and services are rising, sothat the overall level of prices is going up, the economyexperiencesinflation.When the overall level of prices isgoing down, the economy is experiencingdeflation.In theshort run, inflation and deflation are closely related to thebusiness cycle. In the long run, prices tend to reflectchanges in the overall quantity of money. Because inflationand deflation can cause problems, economists and policymakers generally aim forprice stability.